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14 BUSINESS & FINANCE maltatoday, WEDNESDAY, 30 OCTOBER 2013 Reducing VAT on tourist accommodation George Mangion PKF is one of the corporate sponsors to the Malta Hotels and Restaurants Association, representing 70% of all hotels in Malta and 35% of all restaurants, collectively carrying an investment of over €1,200 million and directly employing in excess of 10,000 people. Over its 50 years history MHRA has striven to maintain close contact with government departments and ministries, keeping them aware of the problems facing this industry from time to time. Its contribution towards the improvement of the industry remains continuous and valuable. The vast majority of hotels and restaurants in the Maltese islands, which are its members, confirms its place of importance amongst Malta's employers' unions. Therefore it goes without saying that the hospitality sector felt the need to unite in its quest to safeguard the interests of its members and to continue improving the quality of the tourist product over the years. During the summer months PKF has been working to compile a study and present this to MHRA in order to use it as a tool with the authorities with a view of proving that a reduction in VAT could lead to an enhanced gross value added in general and which would also have a progressive effect on the viability of hotels. The preparation of this extensive econometric study could only be achieved in the short span over the summer months due to the cooperation of a number of hotels which participated in an ad hoc survey. Reliance was placed on the statistics issued periodically by NSO, BOV, MHRA hotel surveys and other technical publications sources. Credit goes to Professor Lino Sant, head of the Statistics Department at University who volunteered to supervise the work of three undergraduate statisticians and other staff through this process. It was a team effort to finish this study for consideration by MHRA council members. First and foremost, VAT is one of the most efficient sources of governmental revenue, providing funds for the government which are subsequently invested into various other economic enterprises and supports the outlays of healthcare and pensions. This study can be instrumental to galvanize the mindset among stakeholders that the hospitality industry faces many challenges but is capable of producing a respectable multiplier advantage due to its many linkages with other sub sectors of the economy. It is a fragile industry which depends on its survival on a number of exogenous factors and thus needs careful nurturing by all its stakeholders. It is true that during the past three years the harvest has been plentiful but the trend is not irreversible albeit it is a healthy sign that on a year-todate basis, the NSO statistics reported a 9.8% increase in arrivals, a 12.9% increase in guest nights and an 11.9% increase in total tourist expenditure. This success in numbers overshadowed the negative effect due to the increase in VAT charged on accommodation in 2011. One must pose the question what would have happened had there been no record arrivals? The PKF study will present the possible consequences on elasticity of demand given that the government reverses the (5% to 7%) 40% increase in VAT rate and reverts to charging the lower rate of 5%. The aim of this study is to evaluate the impact of a possible reduction in the VAT rate on accommodation on the tourism industry and the Maltese economy (but it excludes the computation of the multiplier effect on other industries and consumer institutions). To achieve this, PKF created an econometric model for gross value added to the economy by hotels, the relevant elasticity factors as well as how future predictions could be made. The results obtained suggested that Value Added Tax (VAT) had a negative elasticity in relation to the gross value added (Refer to Section 6.3 of the study). Hence, by decreasing VAT, an increase in gross value added would be recorded. The econometric model was then used to predict future figures for gross value added generated by hotels as well as gross value added generated by accommodation using both 5% and 7% VAT rates in order to enable a comparison between the two predictions. Certain predictions were made using the linear regression models of which the main assumption was that the VAT rate of 5% came into effect as at October 2013. The data made available by the Ministry of Finance included VAT Revenue from other supplies charged at 5% by hotels so this needed to be filtered out to ensure correct and consistent figures throughout the estimation procedures. Due to a lack of information in certain areas, a number of assumptions were made to estimate a host of variables. These estimations were carried out to the best of the knowledge available and were counterchecked by relevant entities to ensure that they were correct. One may question why the study was not extended to cover the potential multiplier effect on so many economic operators with multifaceted linkages for both short and long term results? The answer is twofold - time and expense. The PKF study had no sponsors and by comparison one recalls how in the past a major exercise called the Malta CGE Model (The Economic Impact of Tourism in MaltaComputable General Equilibrium Analysis) was built comprising over 29 industries with three consumer institutions (households, public authorities and the rest of the world) and services, in addition to the intermediate products and 33 markets. Notwithstanding its limitations the PKF survey showed that 65.6% of all the hotels surveyed would reduce their prices partially in the event of a VAT decrease. By attracting larger volumes of tourists, hotels would be inclined to hire more employees in order to cope with the larger amounts of visitors yet 56.2% of hotels surveyed said that they would increase the number of employees marginally if there was a VAT decrease. Again 65.6% of those surveyed believed that there were other factors behind the changes in accommodation prices, besides VAT. A large number of respondents stated that certain factors such as electricity and water costs, the economic recession, COLA (Cost of Living Adjustment) and inflation all contributed towards price changes. On 1 January 2011, a higher rate of VAT on accommodation was introduced. This new rate of 7% superseded the previous rate of 5%, much to the dismay of hoteliers. The increased VAT rate approximately yielded an additional €5.8 million in revenue during 2011, which was expected to be allocated to advertising Malta abroad. Due to the increase in VAT, several hotels registered losses over contracts with tour operators. In order to cover for potential losses made, government came into an agreement with the MHRA giving a partial rebate. Consequently bookings made in advance irrelevant of whether they are full board, half board or all inclusive are charged at 7%. This study aims to investigate the relationships between various factors and to measure the economic impact on owners of hotels of reducing the VAT rate back to 5%. Reading the study one notes that various statistical techniques and tools were used to analyze the data available as well as conducting a survey among hoteliers so as to study such an impact of VAT increase and what they would do in the instance of a potential decrease. As is clear from the values obtained from the model using a 5% rate of VAT on accommodation, these were much more promising than those obtained when using a rate of 7%. At a 7% rate of VAT, gross value added by accommodation was predicted to increase by 19.1%, to €200,766,000. Conversely, a 5% rate of VAT applicable as of October 2013 predicted an increase of 42.7%, giving a total of €240,525,000, therefore, an increase of €40 million. Of course, one must take into consideration the issue of VAT revenue lost by the government. The amount of VAT revenue lost through this decrease in VAT was estimated using the econometric model mentioned earlier and hence could be contrasted with the effect it would have on the economy. By analyzing the forfeiture of VAT revenue and comparing this to the benefits gained in terms of the expansion of the economy, one can arrive at the effectiveness of such a reduction in VAT on accommodation. The survey showed that with the excess revenue generated with the higher prices kept, hotels would reinvest this money into hotel facilities which would subsequently attract tourists in the long term. Hence, in all cases a reduction in VAT will lead to an increase in tourism. This increase in tourism will definitely require hotels to generate vacancies to cope with the increase in tourism. However, as mentioned earlier, the multiplier effect will also come into play. As the number of tourists will rise, other industries such as restaurant, food and beverage services, public transportation, airline and airport operators and retail will also experience an increase in the demand for their products. This demand will encourage these industries to employ more people and hence increase not only the number of gainfully employed people but also the gross domestic product of the entire country. To conclude, readers who are interested in reading the study may apply to MHRA for an advance copy of the Executive summary. Once the publication is presented to the members at the Annual General Meeting to be held next month the full document will be published. Further enquiries can be posted to Tiziana Gauci - Head of Surveys on email tgauci@pkfmalta.com or call 21484373. George Mangion is a partner in PKF an audit and business advisory firm. gmm@pkfmalta.com

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